Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion and analysis represents management’s
view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction
with the consolidated financial statements and other financial schedules included in this annual report. The financial condition
and results of operations presented are not indicative of future performance.
Strategic Overview
ENB Financial Corp and its wholly owned subsidiary, Ephrata National
Bank, are committed to remaining an independent community bank serving the greater communities surrounding Lancaster County, Pennsylvania.
The Corporation’s roots date back to the April 11, 1881 charter granted to Ephrata National Bank by the Office of the Comptroller
of the Currency. The Bank’s growth has been entirely organic over 139 years of existence. The Board and Management are committed
to the principals and values that have served the company well over its long history. In order to remain an independent bank of
undisputed integrity, the Board and Management’s desire is to produce strong financial results that will ensure trust from
the Bank’s depositors and favorable returns to the shareholders over the long term.
Every three years Management and the Board evaluate and revise the
strategic plan to ensure the continuing success of the Corporation into the future. This endeavor is designed to continually sharpen
the products and services the Bank provides in a manner that best serves the customer and attains the financial performance that
shareholders expect. In the most recent strategic plan that covers the years 2019 to 2021, the Board and Management laid out a
five-point plan laying a foundation for success during the next three years and beyond. Succession planning and managing leadership
changes were a key element of this strategic plan. The Board and Management also set into place bold goals to further strengthen
the Corporation’s financial performance ratios so the Corporation is in a position to outperform the local peer group. The
most visible of those targets is to meet and exceed a return on assets of 1.00% and to maintain a return on stockholder’s
equity of over 10.0%, with a target range of 10.5% to 11.0%. Management also desired to reduce the efficiency ratio under 70% for
2020. Management views return on assets as the best overall indicator of a financial institution’s performance. Management
and the Board believe that achieving a higher return on assets will directly correlate to improved earnings per share and dividends
per share, and higher book value of common stock, which in the end will produce higher returns to the shareholder.
Results of Operations
Overview
The year of 2020 was impacted by a number of unprecedented items
caused by the onset of the COVID-19 pandemic. The spread of COVID-19 quickly became global and impacted the global economy. This
impact was felt rather quickly due to China’s large role in the world economy, second in GDP, but first in terms of supply
chain impact for basic goods. The immediate impact and forward risk posed by the pandemic caused the Federal Reserve to take the
unusual step of reducing the Federal Funds rate by 50 basis points to 1.25% on March 3, 2020, at a special Fed meeting ahead of
the regularly scheduled March 18, 2020 meeting. On March 11, 2020, the World Health Organization (WHO) recognized COVID-19 as a
pandemic. The quick further expansion of the pandemic then caused the Federal Reserve to take an unprecedented step of a second
special meeting on Sunday afternoon of March 15, 2020, to further reduce the Federal Funds rate 100 basis points to 0.25%. This
move took the Federal Funds rate to the same historic low of 0.25% that occurred due to the Financial Crisis of 2008. On March
15, 2020, the Fed also reduced the Discount Window rate by 150 basis points, which took this rate down to 0.25%. This move importantly
gave all banks easy access to very low cost funds. On March 16, 2020, the Fed also announced action to inject more liquidity into
the financial system by purchasing up to $500 billion of U.S. Treasuries and $200 billion of mortgage-backed securities. All major
stock exchanges experienced dramatic sell-offs. The DOW, which had peaked at 29,568 in February, closed on Friday, March 20, 2020
at 19,174, down 10,394 points, or 35%. NASDAQ was down 30%, while the S&P 500 was down 32%. Even with a significant equity
market recovery since the initial impact of COVID-19, economic conditions remain uncertain. With the closing of non-essential businesses
throughout various parts of the country for a number of months and a continued impact to consumer spending, it is anticipated that
the financial impact will be long-term. The Coronavirus Aid Relief and Economic Security Act, also known as the CARES Act, was
a $2.2 trillion economic stimulus bill passed by Congress and signed into law on March 27, 2020, by President Donald Trump. The
major provisions of the CARES Act were direct small business aid for employers with fewer than 500 employees; direct deposit stimulus
payments to American households; enhanced unemployment compensation benefits; and direct aid to hospitals and health care
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providers.
The Paycheck Protection Program (PPP) was part of this legislation, which provided relief to businesses and organizations provided
they would retain their workforce and act within the provisions of the plan. The PPP was responsible for the Corporation generating
$77.7 million of loans by September 30, 2020, which was the highpoint in PPP loans for 2020. By December 31, 2020, PPP loan balances
declined to $48.0 million, as a result of loan forgiveness and payoffs.
After December 31, 2020, but prior to the filing of this Form 10-K,
legislation for a second round of PPP loans was passed, which resulted in the Corporation’s total PPP loans increasing again
in early 2021. Consistent with the marketplace, the impact of the second round of PPP was not near as large as the first round.
Management anticipated that $25 million to $30 million of PPP loans would be generated in the second round. Prior to the filing
of this report, the Corporation’s total PPP loans had again started to decline due to further loan forgiveness and payoffs.
The economic impact of COVID-19 had both negative and positive impacts
on the Corporation’s financial results. The Corporation was able to achieve a higher level of earnings in 2020 than in 2019,
but the efficiency of these earnings was reduced. The pandemic caused a very low interest rate environment, which in turn caused
a much larger balance sheet with a historic increase in deposits, increasing the Corporation’s net interest income, despite
a lower net interest margin. The Corporation’s net interest income was also increased by the recognition of PPP loan fee
income. Offsetting the increase in net interest income was a larger increase in the provision for loan losses. As a result of the
pandemic, management was guarded about expected increases in loan losses and higher associated provision for loan losses. Management
did incur $2.2 million more provision for loan loss expense in 2020 than it did in 2019, however much of the provision increase
was focused on a very small number of commercial loans. It remains to be determined what the long-term economic impact of COVID-19
will be on the Corporation’s borrowers and how it will affect the Corporation’s forward earnings.
The Corporation recorded net income of $12,299,000 for the year
ended December 31, 2020, a 7.9% increase from the $11,395,000 earned during the same period in 2019. The 2019 net income was 16.9%
higher than the 2018 net income of $9,749,000. Earnings per share, basic and diluted, were $2.20 in 2020, compared to $2.01 in
2019, and $1.71 in 2018.
The
increase in the Corporation’s 2020 earnings was caused primarily by an increase in mortgage gains from selling mortgage assets
on the secondary market. These gains increased by $3,914,000, or 202.2% in 2020 compared to 2019 due to a high volume of
mortgage refinancings stemming from the very low interest rate environment as well as high margins received on loans sold on the
secondary market.
The
Corporation’s 2020 earnings were also aided by an increase in net interest income of $1,630,000, or 4.5%. Net interest
income accounts for 71% of the gross income stream of the Corporation. The Corporation’s net interest margin decreased in
2020 to 3.24%, from 3.53% in 2019. Loan yields decreased as a result of the Federal Reserve rate decrease in the first quarter
of 2020, immediately impacting the yields on the Corporation’s variable rate loans. The decline in interest expense helped
to partially offset the declining asset yields, but to a much smaller degree.
The financial services industry uses two primary performance
measurements to gauge performance: return on average assets (ROA) and return on average equity (ROE). ROA measures how efficiently
a bank generates income based on the amount of assets or size of a company. ROE measures the efficiency of a company in generating
income based on the amount of equity or capital utilized. The latter measurement typically receives more attention from shareholders.
The Corporation’s 2020 ROA was 0.96%, compared to 1.01% in 2019. ROE decreased from 10.36% in 2019 to 10.16% in 2020. The
decrease in ROA and ROE was primarily due to much higher levels of assets in 2020 compared to 2019 with only moderate growth in
earnings.
The below table highlights the Corporation’s key performance
ratios for the years ended December 31, 2020, 2019, and 2018.
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Key Performance Ratios
Year ended December 31,
The results of the Corporation’s operations are best
explained by addressing in further detail the five major sections of the income statement, which are as follows:
· Net interest income
· Provision for loan losses
· Other income
· Operating expenses
· Income taxes
The following discussion analyzes each of these
five components.
Net Interest Income
Net interest income (NII) represents the largest portion of the
Corporation’s operating income. In 2020, NII generated 71.3% of the Corporation’s gross revenue stream, compared to
76.4% in 2019, and 75.0% in 2018. Since NII comprises a significant portion of the operating income, the direction and rate of
increase or decrease will often indicate the overall performance of the Corporation.
The following table shows a summary analysis of NII on a fully taxable
equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net
interest spread, and net yield on interest earning assets, are presented on an FTE basis. This differs from the NII reflected on
the Corporation’s Consolidated Statements of Income, where the NII is simply the interest earned on loans and securities
less the interest paid on deposits and borrowings. By calculating the NII on an FTE basis, the added benefit of having tax-free
loans and securities is factored in to more accurately represent what the Corporation earns through the NII. The FTE adjustment
shows the benefit these tax free loans and securities bring in a dollar amount because the Corporation does not pay tax on the
income they generate. As a result, the FTE NII shown in both tables below will exceed the NII reported on the consolidated statements
of income. The amount of FTE adjustment totaled $814,000 for 2020, $749,000 for 2019, and $880,000 for 2018.
Net Interest Income
(DOLLARS IN THOUSANDS)
Year ended December 31,
$ $ $
Net interest income
NII is the difference between interest income earned on assets and
interest expense incurred on liabilities. Accordingly, two factors affect NII:
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The Federal funds rate, the Prime rate, the shape of the U.S. Treasury
curve, and other wholesale funding curves, all affect NII. The Federal Reserve controls the Federal funds rate, which is one of
a number of tools available to the Federal Reserve to conduct monetary policy. The Federal funds rate, and guidance on when the
rate might be changed, is often the focal point of discussion regarding the direction of interest rates. During 2020, the Federal
funds rate was decreased by 150 basis points in March taking the rate to 0.25% by March 31, 2020. With the declines in the Federal
funds rate, the U.S. Treasury yield curve became flatter. Long-term rates like the ten-year U.S. Treasury were 232 basis points
under the 3.25% Prime rate as of December 31, 2020. Long-term Treasury rates remained low throughout 2020, and with the decreases
in the Federal Reserve short-term rates, the yield curve remained essentially flat throughout the year. Management had not anticipated
the Fed rate decreases in the first quarter of 2020. With the current flat yield curve throughout most of 2020, it did make increasing
asset yield much more difficult, which added strain to NII and NIM.
The Prime rate is generally used by commercial banks to extend variable
rate loans to business and commercial customers. For many years, the Prime rate has been set at 300 basis points, or 3.00% higher,
than the Federal funds rate and typically moves when the Federal funds rate changes. As such, the Prime rate decreased to 3.25%
in March of 2020 after the 150 basis point Fed rate decline. The Corporation’s Prime-based loans generally reprice a day
after the Federal Reserve rate movement.
As a result of a larger balance sheet in 2020, even with much lower
asset yields, the Corporation’s NII on a tax equivalent basis increased with the Corporation’s margin decreasing to
3.24% for the year, compared to 3.53% in 2019. Loan yields were lower in 2020 due to the 150 basis point Fed rate decline during
the first quarter. The Corporation’s NII for 2020 increased over 2019, by $1,630,000, or 4.5%. Management’s asset liability
sensitivity measurements continue to show a benefit to both margin and NII given Federal Reserve rate increases. Actual results
over the past two years have confirmed the asset sensitivity of the Corporation’s balance sheet. However, in a down-rate
environment, the margin and NII would suffer unless balance sheet growth is enough to offset lower asset yields.
Security yields will generally fluctuate more rapidly than loan
yields based on changes to the U.S. Treasury rates and yield curve. With lower Treasury rates in 2020 compared to 2019, security
reinvestment has generally been occurring at lower yield levels. Because of the lower market interest rates and very flat yield
curve, it is difficult to achieve substantially higher yields in the securities portfolio but there have been some pockets of opportunities
to reposition the portfolio by selling securities at gains and reinvesting in slightly higher yielding instruments to benefit the
Corporation’s earnings going forward.
The Corporation’s loan portfolio yield has decreased from
the prior years’ period as the variable rate portion of the loan portfolio repriced lower with each Federal Reserve rate
movement and some fixed rate borrowers requested loan modifications to reset their rates lower in the current record low market
rate environment. The vast majority of the Corporation’s commercial Prime-based loans were priced at the Prime rate, which
was 4.75% to start 2020, and then 4.25% as of March 4, 2020, and 3.25% as of March 16, 2020 through December 31, 2020. The pricing
for the most typical five-year fixed rate commercial loans is currently in line with the Prime rate. With the significant March
Federal Reserve rate reductions, adding variable rate loans to the portfolio means they will be priced at very low rates to start
but can reprice lower if the Federal Reserve lowers rates any further and would reprice higher if the Federal Reserve would increase
rates. There are elements of the Corporation’s Prime-based commercial loans priced above the Prime rate based on the level
of credit risk of the borrower. Management does price a portion of consumer variable rate loans above the Prime rate, which also
helps to improve loan yield. Both commercial and consumer Prime-based pricing continues to be influenced by local competition.
Mid-term and long-term interest rates on average were much lower
in 2020 compared to 2019. The average rate of the 10-year U.S. Treasury was 0.89% in 2020 compared to 2.14% in 2019, and it stood
at 0.93% on December 31, 2020, compared to 1.92% on December 31, 2019. The slope of the yield curve has been compressed throughout
2019 and 2020. As of March 31, 2019, the U.S. Treasury curve was inverted with the 10-year U.S. Treasury rate 50 basis points lower
than the Fed funds rate. As of December 31, 2020, the 10-year U.S. Treasury rate was only 68 basis points higher than the Fed funds
rate. The slope of the yield curve has fluctuated many times in the past two years with the 10-year U.S. Treasury yield as high
as 1.88% in 2020 and 2.79% in 2019, and as low as 0.52% in 2020, and 1.47% in 2019.
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The Corporation’s overall cost of funds, including non-interest
bearing funds, remained stable through the first quarter of 2020 at 48 basis points, and then decreased throughout the remainder
of the year influenced by lower costs on deposits and the payoff of higher FHLB long-term advances at above-market rates. The Corporation’s
cost of funds steadily declined during the remainder of the year ending at 20 basis points. The Corporation’s costs on borrowings
included $306,000 of prepayment penalties recorded on FHLB long-term advances paid off early during 2020. Management expects the
cost of funds will decline slightly and then stabilize throughout 2021 as deposits reprice to lower rates but this decline should
level out as continued savings become more difficult to achieve. Core deposit interest rates were reduced nine times throughout
2020 and time deposit rates have also decreased resulting in maturing time deposits repricing at lower levels or moving into core
deposit products. Management does not anticipate significant deposit rate movements in 2021 as deposits are now priced at very
low rates. Typically, financial institutions will make small systematic moves on core interest bearing accounts while making larger
rate movements in the pricing of new or reissued time deposits. Borrowing costs, and the wholesale borrowing curves that they are
based on, generally follow the direction and slope of the U.S. Treasury curve. However, these curves can be quicker to rise and
slower to fall as the providers of these funds seek to protect themselves from rate movements. The Corporation prepaid a number
of FHLB advances in 2020 accelerating the interest expense, but achieving savings in future time periods.
The following table provides an analysis of year-to-year changes
in net interest income by distinguishing what changes were a result of average balance increases or decreases and what changes
were a result of interest rate increases or decreases.
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN
THOUSANDS)
Increase (Decrease) Increase (Decrease)
Due To Change In Due To Change In
Net Net
Average Interest Increase Average Interest Increase
Balances Rates (Decrease) Balances Rates (Decrease)
$ $ $ $ $ $
INTEREST INCOME
Securities available for sale:
INTEREST EXPENSE
Deposits:
Borrowings:
In 2020, the Corporation’s NII on an FTE basis increased by
$1,695,000, a 4.5% increase over 2019. Total interest income increased $422,000, or 1.0%, while interest expense decreased $1,273,000,
or 24.9%, from 2019 to 2020.
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The FTE interest income from the securities portfolio decreased by $569,000, or 7.0%, while loan interest
income increased $1,319,000, or 3.9%. During 2020, additional loan volume added $3,929,000 to net interest income, and lower yields
primarily due to the Prime rate decreases in the first quarter of 2020, caused a $2,610,000 decrease, resulting in a net increase
of $1,319,000. Higher balances in the securities portfolio caused an increase of $1,101,000 in net interest income, while lower
yields on securities caused a $1,670,000 decrease, resulting in a net decrease of $569,000.
The average balance of interest bearing liabilities increased by
6.7% during 2020, driven by the growth in deposit balances. Deposit rates decreased significantly throughout 2020 more than offsetting
the slightly higher interest expense caused by much higher balances of deposits. Lower interest rates contributed to $1,449,000
of interest expense reduction while higher balances only caused $36,000 of increased expense, resulting in a total decline in interest
expense of $1,413,000.
Out of all the Corporation’s deposit types, interest-bearing
demand deposits reprice the most rapidly, as these rates can be adjusted lower after a Federal Reserve rate decrease. Demand deposit
interest expense decreased a total of $1,161,000 in 2020, with $1,298,000 due to lower rates, offsetting the higher balances that
caused an increase of $137,000. Interest expense on savings deposits and time deposit balances decreased to a lesser degree. Higher
balances in savings accounts caused an increase of $17,000, while lower rates caused a decrease of $60,000, resulting in the net
decrease in interest expense of $43,000 on savings deposits. Time deposit balances declined throughout 2020, resulting in lower
interest expense of $118,000, while lower rates caused a decline of $91,000, resulting in a net decrease of $209,000.
The average balance of total borrowings decreased by $6.6 million,
or 8.7%, from December 31, 2019, to December 31, 2020. The decrease in total borrowings decreased interest expense by $137,000.
The Corporation paid off FHLB long-term advances during 2020, which resulted in accelerated interest expense causing a $277,000
increase in interest expense associated with higher rates. The aggregate of these amounts was an increase in interest expense of
$140,000 related to total borrowings.
The following table shows a more detailed analysis of net interest
income on an FTE basis shown with all the major elements of the Corporation’s balance sheet, which consists of interest earning
and non-interest earning assets and interest bearing and non-interest bearing liabilities. Additionally, the analysis provides
the net interest spread and the net yield on interest earning assets. The net interest spread is the difference between the yield
on interest earning assets and the interest rate paid on interest bearing liabilities. The net interest spread has the deficiency
of not giving credit for the non-interest bearing funds and capital used to fund a portion of the total interest earning assets.
For this reason, management emphasizes the net yield on interest earning assets, also referred to as the net interest margin (NIM).
The NIM is calculated by dividing net interest income on an FTE basis into total average interest earning assets. The NIM is generally
the benchmark used by analysts to measure how efficiently a bank generates NII.
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COMPARATIVE AVERAGE BALANCE SHEETS
AND NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)
December 31,
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
$ $ % $ $ % $ $ %
ASSETS
Interest earning assets:
Federal funds sold and
Securities available for sale:
LIABILITIES &
STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Non-interest bearing liabilities:
Effect of non-interest bearing funds 0.22 0.27 0.20
Net yield on interest earning assets (c) 3.24 3.53 3.46
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The Corporation’s interest income increased primarily due to increased interest income on loans, but
the increase in income was the result of loan growth, not an increase in asset yield, resulting in a lower NIM of 3.24% for 2020,
compared to 3.53% for 2019. The yield earned on assets decreased by 46 basis points during the year, while the rate paid on liabilities
decreased by 22 basis points when comparing both years. This resulted in a 23 basis point decrease in interest spread, and the
effect of non-interest bearing deposits decreased by six basis points during the year, resulting in the decrease in NIM of 29 basis
points. Management anticipates further declines in NIM during 2021 driven by continued pressure on the Corporation’s asset
yields, which was first fully felt in the second half of 2020. Loan yields decreased in 2020 compared to the prior year primarily
as a result of the 75 basis points of Prime decline experienced in the second half of 2019 and the 150 basis points of Prime decline
in the first quarter of 2020. Growth in the loan portfolio would help to offset a declining asset yield moving through 2021. The
Corporation’s loan yield decreased 34 basis points in 2020 compared to 2019. Loan interest income increased $1,319,000, or
3.9%, for this time period as a result of the growth in balances as well as PPP fees that caused an increase in interest and fees
on loans.
Loan pricing was challenging in 2020 as a result of the very low
rate environment and competition resulting in fixed-rate loans being priced at very low levels and variable-rate loans priced at
the Prime rate or below. The Prime rate was 4.75% as of December 31, 2019, and was moderately higher than the typical business
or commercial five-year fixed rates being extended at that time. The Prime rate decreased by 1.50% in March of 2020 to 3.25%, which
is now comparable to the typical rate of a five-year fixed-rate loan. The commercial or business fixed rates do increase with longer
fixed terms or lower credit quality. In terms of the variable rate pricing, nearly all variable rate loans offered are Prime-based.
Management is able to price loan customers with higher levels of credit risk at Prime plus pricing, such as Prime plus 0.75%, which
amounted to 4.00% at December 31, 2020, still a relatively low rate. However, only a small minority of the loans in the commercial
and agricultural portfolios are at these higher rates due to the strong credit quality of the Corporation’s borrowers and
market competition. Competition in the immediate market area has been pricing select shorter-term fixed-rate commercial and agricultural
lending rates below 3.25% for the strongest loan credits.
Tax equivalent yields on the Corporation’s securities decreased
by 49 basis points for the year ended December 31, 2020, compared to 2019. The Corporation’s securities portfolio consists
of approximately 79% fixed income debt instruments and 21% variable rate product as of December 31, 2020. The Corporation’s
taxable securities experienced a 64 basis-point decrease in yield for the year ended December 31, 2020, compared to 2019. Security
reinvestment in 2020 has been occurring at lower rates due to the significant decline in U.S. Treasury rates. The sharp growth
in the investment portfolio during a period of very low rates also contributed to the decline in average security yield. This large
amount of new investment was caused by the significant influx of deposits, which caused excess liquidity. The sharpest growth in
the securities portfolio occurred in the fourth quarter. In addition to these negative influences, the Corporation’s U.S.
agency mortgage-backed securities and collateralized mortgage obligations experience faster principal prepayments as market rates
decrease, causing the amortization of premium to increase, effectively decreasing the yield.
The yield on tax-exempt securities decreased by 20 basis points
in 2020 compared to 2019. For the Corporation, these bonds consist entirely of tax-free municipal bonds. While the tax-exempt yields
on municipal bonds declined with the tax rate change at the end of 2017, yields became more attractive again during the latter
part of 2019 and throughout 2020. Management began investing in more of these bonds in 2020 as yields stood out and provided better
returns than other sectors of the portfolio.
The interest rate paid on deposits decreased for the year ended
December 31, 2020, from the same period in 2019. Management follows a disciplined pricing strategy on core deposit products that
are not rate sensitive, meaning that the balances do not fluctuate significantly when interest rates change. Rates on interest-bearing
checking accounts and money market accounts were decreased in 2020, resulting in a decrease in the cost of funds on these accounts
of 47 basis points. Savings account rates were also decreased during the year resulting in a two basis point reduction in the cost
of funds associated with these accounts. Additionally, the cost of funds on time deposits decreased by six basis points during
2020. Typically, the Corporation sees increases in core deposit products during periods when consumers are not confident in the
stock market and economic conditions deteriorate. During these periods, there is a “flight to safety” to federally
insured deposits. This trend occurred in 2020. As the rate between time deposits and core deposits narrowed, many customers chose
to transfer funds from maturing time deposits into checking and savings accounts.
Since the financial crisis, depositors have been more concerned
about the financial health of their financial institution. This concern affects their desire to obtain the best possible market
interest rates. This trend benefits the Corporation
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due to its high capital levels and track record of strong and stable earnings.
The Corporation’s Bauer Financial rating of 5, the highest level of their rating scale, has assisted the Bank in gaining
core deposits over the past several years.
The Corporation’s average rate on borrowed funds increased
by 39 basis points from 2019 to 2020, as FHLB borrowings were paid off early throughout the year accelerating $234,000 of interest
expense.
Provision for Loan Losses
The allowance for credit losses provides for losses inherent in
the loan portfolio as determined by a quarterly analysis and calculation of various factors related to the loan portfolio. The
amount of the provision reflects the adjustment that management determines is necessary to ensure that the allowance for credit
losses is adequate to cover any losses inherent in the loan portfolio. The Corporation gives special attention to the level of
underperforming loans when calculating the necessary provision for loan losses. The analysis of the credit loss allowance takes
into consideration, among other things, the following factors:
· levels and trends in delinquencies, non-accruals, and charge-offs,
· levels of classified loans,
· trends within the loan portfolio,
· changes in lending policies and procedures,
· experience of lending personnel and management oversight,
· national and local economic trends,
· concentrations of credit,
· external factors such as legal and regulatory requirements,
· changes in the quality of loan review and Board oversight, and
· changes in the value of underlying collateral.
A provision expense of $2,950,000 was recorded in 2020, compared
to $770,000 in 2019, and $660,000 in 2018. The increase in provision expense was primarily due to a specific allocation related
to a commercial customer with ongoing business concerns as well as a decline in economic and business conditions related to COVID-19,
which caused an increase in the qualitative factors regarding outside market conditions for the entire loan portfolio. This increase
in qualitative factors caused a higher required provision as credit losses may be incurred as businesses deal with the challenges
presented by COVID-19 and the change in business practice. As of December 31, 2020, total delinquencies represented 0.34% of total
loans, compared to 0.91% as of December 31, 2019. These ratios are very low compared to local and national peer groups. The vast
majority of the Corporation’s loan customers have remained very steadfast in making their loan payments and avoiding delinquency,
even during challenging economic conditions. The delinquency ratios speak to the long-term health, conservative nature, and, importantly,
the character of the Corporation’s customers and lending practices. Classified loans are primarily determined by loan-to-value
and debt-to-income ratios. The level of classified loans has decreased from December 31, 2019 to December 31, 2020, from 19.3%
of regulatory capital to 15.0% of regulatory capital. The delinquency and classified loan information is utilized in the quarterly
allowance for credit loss calculation, which directly affects the provision expense. A sharp increase or decrease in delinquencies
and/or classified loans during the year would be cause for management to increase or decrease the provision expense. The allowance
as a percentage of loans increased from 1.25% at December 31, 2019, to 1.50% at December 31, 2020. It is anticipated that the Corporation
will record a provision expense again in 2021 based on projected loan growth and continued economic concerns.
Management also continues to provide
for estimated losses on pools of similar loans based on historical loss experience. Management employs qualitative factors every
quarter in addition to historical loss experience to take into consideration the current trends in loan volume, concentrations
of credit, delinquencies, changes in lending practices, and the quality of the Corporation’s underwriting, credit analysis,
lending staff, and Board oversight. National and local economic trends and conditions are also considered when calculating an appropriate
credit loss allowance for each loan pool. Qualitative factors increased for all loan pools except agriculture dairy in 2020 primarily
due to deteriorating economic conditions due to the COVID-19 pandemic.
Management continues to evaluate the allowance for credit losses
in relation to the growth or decline of the loan portfolio and its associated credit risk, and believes the provision and the allowance
for credit losses are adequate to provide for future losses. For further discussion of the calculation, see the “Allowance
for Credit Losses” section.
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Other Income
Other income for 2020 was $15,360,000, an increase of $4,054,000,
or 35.9%, compared to the $11,306,000 earned in 2019. The following table details the categories that comprise other income.
OTHER INCOME
(DOLLARS IN THOUSANDS)
$ $ $ % $ $ $ %
Net realized gains (losses) on sales
Trust and investment services income decreased by $68,000, or 3.3%, from 2019 to 2020, after increasing 4.2%
from 2018 to 2019. In 2020, trust and investment services revenue accounted for 3.7% of the Corporation’s gross revenue stream,
including gains and losses on securities and mortgages, compared to 4.3% in 2019 and 4.4% in 2018. Trust and investment services
revenue consists of income from traditional trust services and income from investment services provided through a third party.
In 2020, the traditional trust business accounted for $1,245,000, or 63.1%, of total trust and investment services income, with
the investment services totaling $728,000, or 36.9%. In 2020, traditional trust services income increased by $10,000, or 0.9%,
from 2019 levels, while investment services income decreased $78,000, or 9.7%. The amount of customer investment activity drives
the investment services income. A slowdown in activity as a result of COVID-19 caused the decrease in investment services income.
The trust and investment services area continues to be an area of strategic focus for the Corporation. Management believes there
is a great need for retirement, estate, and small business planning in the Corporation’s service area. Management also sees
these services as being a necessary part of a comprehensive line of financial solutions across the organization.
Service charges on deposit accounts for the year ended December
31, 2020, decreased by $329,000, or 23.9%, compared to 2019. Overdraft service charges for 2020, which comprise 78.9% of the total
deposit service charges, decreased to $826,000, from $1,119,000 in 2019, a 26.2% decrease. This decrease was primarily driven by
a change in customer behavior throughout 2020 due to COVID-19 variables. Several other categories of fees increased or decreased
by lesser amounts.
Other fees increased by $247,000, or 18.1%, for the year ended December
31, 2020, compared to 2019. The increase is primarily due to an increase in loan administration fees that were higher by $238,000,
or 78.3%, in 2020 compared to 2019. This was a result of increased secondary market mortgage activity due to the very low interest
rate environment. Additionally, loan modification fees were higher by $219,000, for the year ended December 31, 2020, compared
to the prior year. Partially offsetting these increases, fees on an off-balance sheet cash management product decreased by $270,000,
or 65.3%. Various other fee income categories increased or decreased to lesser degrees making up the remainder of the variance
compared to the prior year.
Commissions increased by $74,000, or 2.6%, for the year ended December
31, 2020, compared to the prior year. The increase was primarily caused by commissions from Banker’s Settlement Services,
which increased by $86,000, or 125.4%, due to increased settlement activity during 2020. Other categories of commissions increased
or decreased by smaller amounts making up the remainder of the variance.
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Management’s Discussion and Analysis
Gains/losses on security transactions were higher for the year ended
December 31, 2020, with a total of $733,000 of gains recorded compared to $499,000 in 2019, a $234,000, or 46.9% increase in income.
Gains or losses taken on securities fluctuate based on market conditions including:
· sale of securities at gains or losses to fund loan growth,
The gains or losses recorded depend on management’s active
trades based on the above as well as unrealized gains or losses on equity securities that are adjusted through income. Losses on
debt securities can be in the form of active sales of securities, or impairment of securities, which involve writing the security
down to a lower value based on anticipated credit losses. There were no impairment charges in 2018, 2019, or 2020, therefore all
security gains and losses incurred during these years were active sales of debt securities designed to either take gains or losses,
or reposition the portfolio, and unrealized gains or losses on equity securities due to market value movements.
The number of debt securities sold in 2020 was higher because of
the very low interest rate environment that presented many opportunities to sell securities at gains. During 2019, the rate environment
was not quite as conducive to taking gains so the gains received were at slightly lower levels. Loan growth was strong in 2019
and PPP loan growth fueled growth in 2020. It continues to be one of the core elements of Management’s plan to increase asset
yield and protect margin, by converting securities into loans and improving the Corporation’s loan-to-deposit ratio.
Gains on the sale of mortgages in 2020 increased $3,914,000, or
202.2%, from 2019. Mortgage activity was significantly higher in 2020 compared to the prior year as a result of historically low
interest rates and a surge in mortgage refinancing activity. The level of gains from the sale of mortgages tends to be aided by
a steady decline in interest rates, which has been the case. Should the direction of interest rates reverse in 2021 and start to
steadily climb, it is likely the level of gains on the sale of mortgages would also decline. Future mortgage volume will be driven
largely by interest rates and the strength of the local economy.
Earnings on bank-owned life insurance (BOLI) increased by $98,000,
or 13.4%, for the year ended December 31, 2020, compared to the prior year. Increases and decreases in BOLI income depend on insurance
cost components on the Corporation’s BOLI policies, the actual annual return of the policies, and any benefits paid upon
death that exceed the policy’s cash surrender value. There were no insurance proceeds received in 2020 or 2019, however the
higher income recorded in 2018 was due to $913,000 of insurance proceeds received in the first quarter of 2018 due to the death
of a participant. Increases in cash surrender value are a function of the return of the policy net of all expenses.
The miscellaneous income category decreased by $116,000, or 24.9%,
for the year ended December 31, 2020, compared to the same period in 2019. The primary reason for the decrease in miscellaneous
income was a decrease in net mortgage servicing income of $140,000, or 296.3%. Mortgage servicing right amortization was elevated
in 2020 due to the very low interest rate environment resulting in lower valuations.
Operating Expenses
The following table provides details of the Corporation’s
operating expenses for the last three years along with the percentage increase or decrease compared to the previous year.
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Management’s Discussion and Analysis
OPERATING EXPENSES
(DOLLARS IN THOUSANDS)
$ $ $ % $ $ $ %
Computer software & data
Salaries and employee benefits are the largest category of operating
expenses. In general, they comprise 61% of the Corporation’s total operating expenses. For the year 2020, salaries and benefits
increased $1,030,000, or 4.9%, compared to 2019. Salaries increased by $859,000, or 5.5%, and employee benefits increased by $171,000,
or 3.1%, for 2020, compared to 2019. Salary costs were higher for the year due to higher commissions paid out on mortgage production,
which were partially offset by higher deferred costs on loan originations, which are recorded as a contra salary expense. Additionally,
salary costs were higher due to a performance bonus paid out in the first quarter of 2020. Employee benefits expense was at a
higher level due to higher health insurance costs, which increased by $207,000, or 7.7%, for 2020 compared to 2019.
The Corporation has a 401(k) Savings Plan under which the Corporation
makes an employer matching contribution, a non-elective safe harbor contribution and a discretionary non-elective profit sharing
contribution. The employer matching contribution is made on the compensation of all eligible employees, up to a maximum of 2.5%
of an eligible employee’s compensation, at $0.50 for every $1.00 of employee contribution up to 5% of an eligible employee’s
salary. The employer non-elective safe harbor contribution is 3% of all employee compensation for the year. Based on the performance
of the Corporation, the Compensation Committee determined the discretionary non-elective profit sharing contribution would be 2%
of all eligible employee compensation. For the Corporation, the expense of the 401(k) matching contribution will be smaller than
the non-elective safe harbor and the discretionary non-elective profit sharing expenses, as the Corporation is matching a maximum
of up to 2.5% of salary, depending on employee contributions, compared to contributing up to 5.0% of eligible employee’s
salaries in the safe harbor and discretionary profit sharing contributions. The 401(k) matching contribution expense of the 401(k)
Savings Plan increased $35,000, or 9.6% in 2020, a function of greater employee participation.
Occupancy expenses consist of the following:
· Depreciation of bank buildings
· Real estate taxes and property insurance
· Utilities
· Building repair and maintenance
· Lease expense
Occupancy expenses have decreased by $25,000, or 1.0%, for 2020
compared to 2019. Utilities costs decreased by $21,000, or 3.0% in 2020 compared to 2019, primarily a result of lower electricity
and oil costs. Various other occupancy categories increased or decreased to lesser amounts making up the remainder of the variance.
Equipment expenses increased by $24,000, or 2.0%, for 2020 compared
to 2019. Equipment repair and maintenance costs increased by $64,000, or 118.6% in 2020 compared to the prior year, offset by lower
equipment depreciation expenses and lower service contract expenses, which declined by $47,000, or 6.3%, and $36,000, or 13.2%,
respectively. Other equipment-related expenses increased or decreased to lesser degrees making up the remainder of the variance.
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ENB FINANCIAL CORP
Management’s Discussion and Analysis
Advertising and marketing expenses for the year increased by $74,000,
or 9.0%, from 2019 levels. These expenses can be further broken down into two categories, marketing expenses and public relations.
The marketing expenses alone totaled $686,000 in 2020, which was a $150,000, or 28.1% increase, over 2019. Marketing expenses support
the overall business strategies of the Corporation; therefore, the timing of these expenses is dependent upon those strategies.
Public relations, the smaller category of advertising and marketing expenses, totaled $208,000 for 2020, compared to $284,000 for
2019, a decrease of $76,000, or 26.8%. Fairs and expos, promotional items, and sponsorships make up this category.
Computer software and data processing expenses increased by $511,000,
or 19.4%, for 2020 compared to 2019. Software-related expenses were up by $393,000, or 26.6%, for the year ended December 31, 2020,
compared to the prior year, primarily because of increased software maintenance agreement expenses, which support the overall strategy
of the Corporation to gain efficiency. Management conducts internal studies showing rates of return on investment on all major
software initiatives to ensure total cost savings that more than offset the total cost of implementation over the life of the software.
Management’s goal on all software investments is to improve processes, to provide better customer service, while also resulting
in lower net salary and overhead costs. Software expenses are likely to continue to increase in 2021, but the actual increase will
be dependent on how quickly new software platforms are identified, analyzed, approved and placed into service. Data processing
fees were up $119,000, or 10.2%, for the year ended December 31, 2020, compared to the same period in 2019. These fees increase
with the increase in customer transactions as well as any increases in debit card related fraud/charge-off expenses.
Bank shares tax expense was $1,060,000 for 2020, an increase of
$130,000, or 14.0%, from 2019. Two main factors determine the amount of bank shares tax: the ending value of shareholders’
equity and the ending value of tax-exempt U.S. obligations. The shares tax calculation uses a period-end balance of shareholders’
equity and a tax rate of 0.95%. The increase in 2020 can be primarily attributed to the Corporation’s growing value of shareholders’
equity.
Professional services expense increased $229,000, or 11.0%, for
2020, compared to 2019. These services include accounting and auditing fees, legal fees, and fees for other third-party services.
The Corporation began using contracted employees in 2020 to fill some temporary employment positions. These fees amounted to $70,000
with no corresponding expense in 2019. Additionally, legal fees increased by $56,000, or 54.8%, for 2020 compared to 2019, primarily
driven by legal fees related to the subordinated debt transaction that occurred in December of 2020. Outside services costs increased
by $42,000, or 4.3%, and accounting and auditing fees increased by $40,000, or 11.2%, for 2020 compared to the prior year. Other
professional services expense categories increased or decreased to lesser degrees making up the remainder of the variance.
Other operating expenses increased by $468,000, or 18.6%, for the
year ended December 31, 2020, compared to the same period in 2019. Contributing to this increase, loan-related expenses increased
by $405,000, or 74.7% for the year, driven primarily by an increase in the provision for off balance sheet credit losses that was
impacted by higher qualitative factors in 2020. Additionally, FDIC insurance costs increased by $81,000, or 57.3% in 2020 compared
to the prior year. Operating supplies and fraud-related charge-offs increased by $93,000, or 34.4%, and $44,000, or 254.8% respectively,
for the year ended December 31, 2020, compared to the prior year. Partially offsetting these increases, travel-related costs were
down $140,000, or 62.6%. Several other operating expense categories increased or decreased by smaller amounts making up the remainder
of this variance.
Management uses the efficiency ratio as one metric to evaluate the
Corporation’s level of operating expenses. The efficiency ratio measures the efficiency of the Corporation in producing one
dollar of revenue. For example, an efficiency ratio of 70% means it costs seventy cents to generate one dollar of revenue. A lower
ratio represents better operational efficiency. The formula for calculating the efficiency ratio is total operating expenses, excluding
foreclosed property and OREO expenses, divided by net interest income on an FTE basis, prior to the provision for loan losses,
plus other income, excluding gain or loss on the sale of securities. A higher level of operating expenses may be justified if the
Corporation is growing interest earning assets and is increasing net interest income and other income at faster levels. This was
the case in 2020 as the Corporation’s efficiency ratio was 67.2%, compared to 69.8% for 2019. Management has been successful
in increasing both net interest income and fee income during this period, as well as holding operating expenses to lower growth
rates, resulting in improved efficiency. In 2021, management anticipates possible compression in net interest margin, which could
result in lower net interest income making improvements in efficiency more difficult to achieve. While management desires a lower
efficiency ratio, the desire to capture additional market share in the near future and the interest rate environment, including
the timing of the Federal Reserve’s rate actions, will play a large part in determining when the Corporation’s efficiency
ratio improves further and the degree to which additional improvements can be made.
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ENB FINANCIAL CORP
Management’s Discussion and Analysis
Income Taxes
Nearly all of the Corporation’s income is taxed at a corporate
rate of 21% for Federal income tax purposes. The Corporation is also subject to Pennsylvania Corporate Net Income Tax; however,
very limited taxable activity is conducted at the corporate level. The Corporation’s wholly owned subsidiary, Ephrata National
Bank, is not subject to state income tax, but does pay Pennsylvania Bank Shares Tax. The Bank Shares Tax expense appears on the
Corporation’s Consolidated Statements of Income under operating expenses.
Certain items of income are not subject to Federal income tax, such
as tax-exempt interest income on loans and securities, and increases in the cash surrender value of life insurance; therefore,
the effective income tax rate for the Corporation is lower than the stated tax rate. The effective tax rate is calculated by dividing
the Corporation’s provision for income tax by the pre-tax income for the applicable period.
For the year ended December 31, 2020,
the Corporation recorded a tax provision of $2,285,000, compared to $2,126,000 for 2019.
This increase in tax expense can be attributed to higher pretax earnings. The effective tax rate for the Corporation was
15.7% for 2020 and 2019. The Corporation’s effective tax rate is lower than the 21% corporate rate as a result of tax-free
assets that the Corporation holds on its balance sheet. The majority of the Corporation’s tax-free assets are in the form
of obligations of states and political subdivisions, referred to as municipal bonds. The Corporation also has a relatively small
component of tax-free municipal loans.
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ENB FINANCIAL CORP
Management’s Discussion and Analysis
Financial Condition
Cash and Cash Equivalents
Cash and cash equivalents consist of the cash on hand in the
Corporation’s vaults, operational transaction accounts with the Federal Reserve Bank (FRB), and deposits in other banks.
The FRB requires a specified amount of cash available either in vault cash or in an FRB account. Known as cash reserves, these
funds provide for the daily clearing house activity of the Corporation and fluctuate based on the volume of each day’s transactions.
Beyond these requirements, the Corporation maintains additional cash levels as part of Management’s active asset liability
and liquidity strategy. Management has been carrying larger cash balances as a result of the large increase in deposit balances
during 2020 with lower levels of loan growth. Additionally, higher cash balances provide an immediate hedge against interest rate
risk and liquidity risk. As of December 31, 2020, the Corporation had $94.9 million in cash and cash equivalents, compared to $41.1
million as of December 31, 2019.
The overnight rate that the Federal Reserve Bank pays on excess
cash balances fluctuates as the overnight Federal Funds rate fluctuates and as of December 31, 2020, it stood at 0.10%. The Corporation
does not aim to keep excess cash at the FRB as the overnight rate is much less then rates received on balances held in correspondent
money market accounts. Management invests excess cash in three money market accounts at other financial institutions. The money
market accounts yielded a return of 0.15%, 0.31%, and 0.35% at December 31, 2020, all more than the return received from the FRB.
This diversification alters the mix of cash and cash equivalents to more interest bearing deposits in banks and less Federal funds
sold. The cash and cash equivalents represent only one element of liquidity. For further discussion on liquidity management, refer
to Item 7A Quantitative and Qualitative Disclosures about Market Risk.
Sources and Uses of Funds
The following table shows an overview of the Corporation’s